Insolvency M&As: cleared for takeover

The volume of M&A deals has fallen in recent months, as buyers proceed
with caution and face up to financing difficulties in the context of the
economic downturn.

Yet while some businesses ­ particularly in the financial services sector ­
are looking to restructure, divest and demerge as a means of raising capital,
others consider that now is precisely the right time to invest in distressed
businesses, including those that have already gone into administration.

Not only are private equity firms setting up new funds to focus on distressed
investments, but the economic slowdown is presenting ambitious chief executives
with the opportunity to purchase rival businesses at low prices.

In an economic downturn corporate transactions may involve:

investors pursuing opportunities to make straightforward acquisitions of
target businesses at low prices;

investors restructuring their existing shareholdings or selling on
distressed subsidiaries as a means of raising capital;

banks swapping debt for equity; or

administrators looking to rescue and/or repackage failing businesses and
sell them on as a going concern in order to secure a high return for creditors.

Whatever the motivation behind a deal, these transactions may require merger
control clearance. Although under both the EC Merger Regulation (the ‘ECMR’) and
the equivalent domestic rules of many EU Member States, transfers of businesses
to insolvency practitioners such as administrators or liquidators will not
normally be subject to merger control review, subsequent disposals by those
insolvency practitioners will be subject to review in the usual way ­ as will
other transactions that result in a change in identity of shareholders in a
business.

In the vast majority of countries (the UK being the notable exception) and
under the pan-European merger control regime, if your transaction falls within
the jurisdiction of the merger control authorities you have to apply for
clearance in advance and obtain that clearance before you can complete even if
the deal raises no substantive competition concerns. This requirement has an
immediate impact on transaction timing.

How do you decide if a transaction might need merger
clearance?

Although the details of the jurisdictional thresholds and procedures of
merger control regimes vary from country to country, most countries base their
jurisdiction on a combination of whether the transaction:

results in a ‘change in control’ of a business ­ with control being given a
very extended meaning that can include the acquisition of a minority interest in
some cases or the establishment of a joint venture; and

meets the relevant financial thresholds (typically determined by the
worldwide group turnovers of the target and the party (or parties) acquiring
control and their group revenue from customers in particular countries). Being
competitors or having a high combined market share is not a necessary condition
for most merger control regimes to apply.

Surely some allowance is made for a business downturn?

Under most merger control regimes there are some limited exceptions to the
general rules which have grown up to take account of the economic difficulties
surrounding a transaction.

In urgent cases, is it possible to get a waiver to complete without
clearance?

Under the ECMR ­ in common with the merger control rules of several (but not
all) EU member states ­ the European Commission does have a margin of discretion
to allow transactions to be completed even if merger clearance has not yet been
obtained.

In practice, however, the European Commission has only granted this type of
derogation in a limited number of cases ­ such as in ING/Barings where the
target was in immediate danger of insolvency ­ and would be reluctant to do so
in cases which may give rise to substantial competition concerns.

Is it possible to acquire a competitor on the verge of
collapse?

Both the ECMR and the merger control rules of many EU jurisdictions recognise
a concept known as the ‘failing firm defence’, under which a merger ­ usually
between direct competitors ­ that would otherwise be blocked due to its adverse
effect on competition is permitted when the target is a failing firm and an
alternative, less detrimental merger is unavailable.

It must be stressed however that competition authorities have shown
considerable reluctance to accept the failing firm defence. It has been
successfully used in just a handful of cases. In particular, the standard of
proof for demonstrating that one of the parties to a transaction is ‘failing’ is
high and, in practice, firms on the verge of (or possibly even in)
administration might not meet the test.

Even if the target is failing, the competition authorities may prefer to see
the target’s customer base split between a number of competitors rather than
moving to the existing market leader.

I thought they had torn up the merger control rules anyway?

The high profile government intervention, swift legal reform and equally
swift judicial challenge before the Competition Appeal Tribunal witnessed in the
context of the Lloyds TSB/HBOS merger begs the question whether politics will
take precedence over the competition rules in a range of rescue deals to come.

The clear message here is that Lloyds TSB/HBOS has to be read in context.
Against the background of financial crisis in the banking sector — and faced
with the prospect of a long and painful competition investigation — the
government has made allowances for the process to be fast tracked, taking the
view that stability has outweighed normal competition concerns.

Going forward, it is likely that the UK government will only invoke public
interest criteria to allow mergers to proceed in exceptional circumstances.
Businesses entering into transactions in response to the economic slowdown ­ be
they straightforward purchases of distressed companies, rescue packages
involving debt for equity swaps or restructurings involving the purchase of an
increased, controlling stake ­ must not forget to factor merger clearance into
their deals.

Difficult economic times can only be used to trump the application of the
competition rules under very limited circumstances and merger clearance
continues to have a major impact on the timing of transactions.

Lesley Ainsworth is a partner and Wayne Spillett an
associate in the Competition & EU law practice at Lovells LLP